OLIGOPOLY

MEASURE OF MARKET POWER

Concentration ratio is the most
common measure of market power
(the degree of control that a single
firm or small number of firms have
over the price and production
decision in an industry)
 Pure Monopoly: 100% (for 8 firms)
 Perfect competition: 0%

Alternative measure which better

capture the role of dominant firm
is Herfindahl-Hirchman Index
(HHI)
THE NATURE OF IMPERFECT COMPETITION
• Economies of scale
Cost • Few firms can
profitably survive

Barrier to • Large economies of Imperfect

scale Competition
Competition • Government
restriction
• Interdependence of few
Strategic firm that operate in a
Interaction market
• Each firm’s business
depends upon the
behavior of its rival
TYPES OF IMPERFECTLY COMPETITIVE
MARKETS
Oligopoly
 Only a few sellers, each offering a similar or identical product to
the others.
Monopolistic Competition
 Many firms selling products that are similar but not identical.
 Number of Firms?

Many
firms

Type of Products?

One Few Differentiated Identical

firm firms products products

Monopolistic Perfect
Monopoly Oligopoly Competition Competition
(Chapter 15) (Chapter 16) (Chapter 17) (Chapter 14)

• Tap water • Tennis balls • Novels • Wheat

• Cable TV • Crude oil • Movies • Milk

Copyright © 2004 South-Western

OLIGOPOLY MARKET
Characteristics:
 Few sellers offering similar or identical products
 Interdependent firms
 Best off cooperating and acting like a monopolist by producing a small quantity of
output and charging a price above marginal cost

Because of the few sellers, the key feature of oligopoly is the tension
between cooperation and self-interest.
A duopoly is an oligopoly with only two members. It is the simplest
type of oligopoly.
THEORIES OF IMPERFECT COMPETITION: COLLUSIVE
OLIGOPOLY
Behavior among small number of firms

Non-cooperative Cooperative
They act on their own without They try to minimize competition
any explicit or implicit
agreement with other firms
Collusion: two or more firms jointly
set their price or output and divide
Price War the market among them selves

Firms often engage tacit A Cartel: an organization of

collusion (refrain from independent firms, producing similar
competition without explicit product, work together to raise price
agreement) and restrict output
Collusive Oligopoly agree to charge
the same price and share the market
By joining together, the price will be very
close to that of a single monopolist and it
can be maximize their joint profit (jointly
profit-maximizing price)
 OBSTACLES HINDER EFFECTIVE COLLUSION…
1. Collusion is illegal
2. Firm may “cheat’ on the agreement by cutting their price to
selected customers, thereby increasing their market share. It is
possible where:
 Price are secret
 Goods are differentiated
 There is more than a handful of firms
 The technology is changing rapidly
Indeed, experience shows that running a successful cartel is a
difficult business, whether the collusion is explicit or tacit,
example: OPEC.
 THE EQUILIBRIUM FOR AN OLIGOPOLY
 A Nash equilibrium is a situation in which economic actors
interacting with one another each choose their best strategy
given the strategies that all the others have chosen.
 When firms in an oligopoly individually choose production to
maximize profit, they produce quantity of output greater than
the level produced by monopoly and less than the level
produced by competition.
 The oligopoly price is less than the monopoly price but greater
than the competitive price (which equals marginal cost).
 HOW THE SIZE OF AN OLIGOPOLY AFFECTS THE MARKET
OUTCOME
 How increasing the number of sellers affects the price
and quantity:
 The output effect: Because price is above marginal cost, selling
more at the going price raises profits.
 The price effect: Raising production will increase the amount
sold, which will lower the price and the profit per unit on all
units sold.
 GAME THEORY
(JOHN VON NEUMANN, 1903 – 1957)
Game Theory analyzes the ways in which two or more player
choose strategies that jointly affect each other.
Because the number of firms in an oligopolistic market is small, each
firm must act strategically.
Each firm knows that its profit depends not only on how much it
produces but also on how much the other firms produce.
It suggest that in some circumstance a carefully chosen random
pattern of behavior may be the best strategy.
The basic rule of Game Theory: “You should choose your strategy
based on the assumption that your opponents will act in their own
best interest”
 THE PRISONERS’ DILEMMA

 The prisoners’ dilemma provides insight into the difficulty in

maintaining cooperation.
 Often people (firms) fail to cooperate with one another even
when cooperation would make them better off.
 The prisoners’ dilemma is a particular “game” between two
captured prisoners that illustrates why cooperation is difficult to
maintain even when it is mutually beneficial.
Charging in the normal price is a Dominant Strategy for both firms in this
particular price-war game
Nash Equilibrium: No player can gain anything by changing his own strategy, given the
other player’s strategy
 PRICE DISCRIMINATION

Profit; single price = $1,200; PD = $1,350 (improve welfare?)

It is widely used particularly with goods that are not easily transferred from the low-
priced market to the high-priced market
 CONTOH PERHITUNGAN MATEMATIS DISKRIMINASI HARGA
(MATEMATIKA EKONOMI & APLIKASINYA, BUMULO & MURSINTO, 129-130)
Permintaan: A: Q1 = 1.000 – 0,1P1: B: Q2 = 2.000 – 0,4P2
TC = 1.000Q + 750.000  MC = 1.000
Diskriminasi Harga
 P1 = 10.000 – 10Q1; TR1 = 10.000Q1 – 10Q12; MR1 = 10.000 – 20Q1
MR1 = MC  Q1 = 450; P1 = 5.500
 P2 = 5.000 – 2,5Q2; TR2 = 5.000Q2 – 2,5Q22; MR2 = 5.000 – 5Q2
MR2 = MC  Q2 = 800; P2 = 3.000
 Profit: (TR1 + TR2) – TC = (P1Q1 + P2Q2) – TC = 2.875.000

Tanpa Diskriminasi Harga:

 P = P1 = P2; Q = Q1 + Q2 = 3.000 – 0,5P  P = 6.000 – 2Q; TR = 6.000Q – 2Q2; MR =
6.000 – 4Q
 MR = MC  Q = 1.250 P = 3.500
 Profit = TR – TC = 1.375.000
 ECONOMIC COST OF IMPERFECT COMPETITION

Deadweight loss: the loss of economic welfare

arising form distortion in price and output (“static
Monopolist’s
cost” of monopoly that assume technology for
profit
producing output is unchanging

equilibrium for competitive

market, P = MC (E)
equilibrium for competitive
market, MR = MC (A)